The Federal Reserve's recent report, showing large commercial bank passthrough holdings plunging by $63.5 billion to $367.3 billion, from $430.8 billion in the week ending June 15, spurred a flurry of theories as to how the big dip came about.
"The question is whether the data is noisy," said Glenn Boyd, head of MBS strategy at Barclays Capital. He noted that the huge drop has put bank holdings at their lowest level since 2004. Although the extent of the downward movement is unprecedented, there was a significant $80 billion rise in holdings earlier in the year. Typically, bank MBS holdings sway up or down by no more than $5 billion to $10 billion increments.
Federal Reserve data is based on volunteer information so different banks are reporting their numbers using their own methodology, explained Boyd. Although the Fed instructs banks to report their transactions on the trade date, there is anecdotal evidence that some banks report their deals on the settlement date, which could have an impact on the aggregated data. Dollar rolls would not count as MBS holdings if trade date accounting is used, but could if settlement date accounting is used. Some banks' accounting firms treat dollar rolls as sales and purchases, rather than financings. For those banks, the June/July roll shows up as selling in June, and buying in July. A bank using settle date accounting and sale/purchase treatment would therefore show a drop in MBS holdings after June settlement, since the offsetting July purchase would not show up until July.
Boyd said that the most probable explanations for the decrease would be a combination of bank rolling and net selling, with Mega pool creation being a less likely culprit. In terms of Mega pool creation, Boyd said one of the large banks could have created a Mega and delivered it to the dealer just before reporting to the Fed, although this would not be likely as a forward purchase agreement is typical in these transactions. He added that what exactly happened in the June 15 report would be clarified after second quarter bank filings come out.
"On balance, the significant rolling and selling is negative on the market, specifically in 5s, where the activity is most likely taking place," said Boyd. He pointed out that rolls in 5s are cooling off and have become relatively less attractive.
Separately, Merrill Lynch analysts said that banks selling large amounts of mortgages - the simplest explanation for the huge dip - is partially true, estimating that banks sold at least $20 billion to $30 billion of passthroughs to dealers. But if $63 billion were sold, Merrill said that it is surprising that dealer inventories merely increased by $23 billion. It would be hard to sell $40 billion in passthroughs to investors without creating a market ripple especially since the GSEs are not growing their agency MBS portfolios as much. It is possible, Merrill concluded, that not all the bank portfolio reduction reported as of June 15 could be attributed to net sales, but was due to rolling, distribution of securities and Mega creation.
The large dip is likely a negative for MBS, Merrill said. "With the market rallying and dealer holdings at their highs for quite some time, the news that banks have sold a large amount of MBS is likely to make the sector trade poorly," Merrill analysts wrote, adding that they suggest a modest underweight position in conventional 30-year collateral at this juncture.
JPMorgan Securities vouched for the Federal Reserve data's historical accuracy. "It is not some sort of vague survey," analysts wrote, adding that the Fed's numbers have tracked the full quarterly bank releases closely. "Restatements from the Fed have been rare and never exceeding more than a couple of billion dollars." Furthermore, JPMorgan said that the Fed's data is as of settlement date thus it should show June settlement sales, excluding dollar rolls as well as available for sale accounts that roll or that treat the transaction as a financing rather than a sale and purchase. Analysts acknowledged that late settlement Mega or Giant purchases were not necessarily reflected in the June 15, report, but would show up on a report scheduled for release last Friday. However, analysts insisted that they have never seen a large rise in same-month settle purchases following a large dip, adding that they only expected a modest rise in the next bank holdings report.
JPMorgan added that the sales happened for quarter end, allowing banks to realize 2Q05 gains, explaining that buying back the same security within 30 days would result in a wash sale. JPMorgan analysts also noted the $23 billion rise in net dealer MBS positions, reporting that had there been considerable forward bank purchases, these positions would not have been as large. The Fed dealer holdings report shows exposure as of trade date since it is for trading rather than available-for-sale accounts.
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